ResCap's Missed Payment Means More Subprime RMBS Trouble

Residential Capital's (ResCap), Ally Financial's troubled mortgage unit, missed coupon payment indicated that it is heading toward bankruptcy. The firm might also be using the threat of a bankruptcy to get investors to reduce ResCap's debt burden, according to a Barclays Capital securitization research note.

ResCap parent Ally announced yesterday that its wholly owned subsidiary did not make a scheduled interest payment on its 6.5% notes due April 2013 with $473 million outstanding. ResCap now has a 30-day grace period before creditors can accelerate the debt and declare an event of default.

If the company is going to be or threatening to file for bankruptcy, Barclays analysts said that either scenario would have some implications for RMBS serviced by ResCap or its subsidiaries.

Discussion over a possible ResCap bankruptcy have been ongoing now for a few years due to its heavy exposure to credit losses from mortgages originated between 2005 and 2007.

Talks had picked up more momentum late last year when Ally was reportedly considering various options for ResCap, Barclays analysts noted.

They noted that last week, Ally extended the maturity on $2.1 billion in secured credit facilities to ResCap by a month to May 14. This is a day before a $102 million scheduled interest payment is due on the servicer's 9.625% notes maturing in May 2015.

"Given the timing of the extension, market sentiment had already been questioning whether the parent was planning to file ResCap for insolvency in the near term," they said.

If ResCap becomes insolvent, the pooling and servicing aggrements (PSAs) on the RMBS trusts it services give the trustee the option to terminate the master servicer's rights and obligations.

Barclays analysts explained that the trustee would be required to terminate the master servicer's responsibilities if directed to by 51% or more of the certificate holders. The trustee would then succeed to the master servicer's role and be entitled to a similar compensation arrangement or it could appoint another successor servicer.

"In theory, this would be an issue for all the deals master serviced by ResCap," analysts said in the report. "In practice, this is relevant only for deals in which ResCap is also the primary servicer (the majority of cases)."

They said that if ResCap is unable to sell the mortgage servicing rights before a bankruptcy filing, both the GSEs and the trustees of the non-agency MBS trusts have the right to transfer the servicing rights away from ResCap without compensation.

This would mean that ResCap creditors and equity holders would look to sell the servicing rights to a third-party before an insolvency filing to maximize value for the equity/bondholders, according to the report.

"In the unlikely scenario of a servicing disruption, ResCap would be less likely to make P&I advances on delinquent loans, given that it would be less likely to be able to fund those advances," analysts said in the report. "It is also possible that there could be some interruptions with passing cash flows from the non-agency trusts to MBS bondholders if operational issues occur with a filing, despite the cash being held in segregated accounts."

In deals where ResCap is both the primary servicer and the master servicer, a smooth servicing transfer will likely happen before a filing, analysts explained.

"In both scenarios, there is, of course, an additional risk that only those servicing assets that have a positive NPV are sold while the worse quality, lower balance delinquent loans are left at Rescap," they stated. "If done at the deal level, this will have significant negative implications for high delinquency lower balance subprime deals serviced by Rescap."

Analysts explained that finding a replacement servicer for low-balance/high-delinquent deals might be challenging. Under this scenario, bondholders in subprime deals might be more negatively affected versus other sectors, they said.

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